Loans 101 - Equity; What is it and how you can use it to your advantage?
Equity…
Most of us have heard of this term, Equity, but what does it really mean? Is it a term you should be across…?
Imagine this…
Lets keep things simple. Imagine you bought a house for $100,000 (I know, I know…houses don’t cost $100,000 anymore, but lets just run with the example). You have $20,000 worth of deposit and have to borrow the remaining $80,000.
Given that you borrowed $80,000 and the cost of the house is $100,000, your loan-to-value ratio (LVR) is 80% - in other words, you have borrowed 80% of the property’s value.
Your equity is defined as the difference between the value of the asset ($100,000) and the amount of debt you have connected to the asset ($80,000). Equity = $100,000 - $80,000 = $20,000.
Equity over time…
2 years have now passed and your home is worth $200,000 (wow, that’s some great capital growth haha). You have paid some of the principal off, so the amount of debt has gone down from $80,000 to $70,000.
Value of house now = $200,000
Debt = $70,000
Equity = value of the house - debt = $200,000 - $70,000 = $130,000.
Your equity, therefore, is now $130,000; the difference between the value of the house now and the amount of debt remaining.
Okay, this makes sense…But what does this actually mean and how can I use it?
This $130,000 in equity can be thought of as the value in your home you haven’t used. It’s akin to having a credit card with a limit of $130,000 that you haven’t yet used. You have the option to extract this value out of your property and use it to buy other things. This is known as an equity cash out. Typically, people extract equity to purchase another property - you have $130,000 to put towards a deposit for another property. Or, you can buy a car, renovate the family home, or go on a holiday…
Equity can be a powerful tool, especially if you have owned a home for several years. It can propel you to buy your next investment property and build your portfolio. As always, there is a little more nuance to the concept and extraction of equity. Get in touch with us on 0422 854 342 for more info.
